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Canadian bonds beat peers by most in five years

Canadian bonds are outperforming global counterparts by the widest margin in half a decade as debt turmoil and concern the U.S. recovery is stalling send investors to nations with the soundest balance sheets

Canadian bonds are outperforming global counterparts by the widest margin in half a decade as debt turmoil and concern the U.S. recovery is stalling send investors to nations with the soundest balance sheets.

Bonds issued by Canadian governments and companies returned 2.21% last month, led by Rogers Communications Inc., Epcor Utilities Inc. and Quebec, according to a Bank of America Merrill Lynch index tracking 1,179 bonds with $1.1 trillion outstanding. That compares with a gain of 1.16% in Merrill’s broad global index. The gap of 1.04 percentage points is the widest since July 2006.

“Canada’s a pure AAA that’s attractive to foreign reserve managers,” said James Dutkiewicz, a fund manager who oversees about C$7 billion in bonds at CI Financial Corp. in Toronto. “It has a stable, strong currency and a weak enough economy that continues to delay Bank of Canada tightening.”

International investors are purchasing Canadian bonds at a record pace, pushing the country’s currency to the strongest in almost four years. Canada’s debt is 34% of gross domestic product, about a third of the U.S. ratio at 94%. Germany’s debt-to-output ratio is 83%, the U.K.’s is 149% and Japan’s is 226%.

Standard & Poor’s, which has given the U.S. a top AAA ranking since 1941, said on July 14 that the chance of a downgrade is 50% in the next three months and may cut the rating as soon as August if there isn’t a “credible solution” to reduce the nation’s deficit.

Narrowing Deficit

Canada’s 2011 fiscal plan, released June 6, projects a deficit of $36.2 billion for the fiscal year that ended in March, down from an initially projected $40.5 billion, because of lower program spending. The deficit is projected to swing to a surplus of $4.2 billion for the 2015 fiscal year.

Elsewhere in credit markets, the extra yield investors demand to hold the debt of Canada’s corporations rather than its federal government ended last week at 133 basis points, one basis point wider than in the prior week. Canadian markets were closed yesterday for a holiday. The nation’s corporate bonds have returned 2.15% in July, compared with 2.29 percent for U.S. company debt.

“Canada, and especially the Canadian financial sector, is still operating under a bit of a halo effect, since our economy and especially our banks came through the credit crisis so well,” said Robert Follis, managing director of corporate bond research at Scotia Capital in Toronto. “When the broad economy gets into a bit of trouble, Canada and the Canadian corporate issuers look pretty good.”

Provincial Bonds

Yields on two-year Government of Canada bonds fell nine basis points on July 29, the most since June 15, to 1.4%. The Canadian two-year yield was 1.04 percentage points above equivalent-maturity U.S. Treasuries, compared with 1.11 percentage points on July 22.

In provincial bond markets, yields closed at 56 basis points last week, one basis point wider than in the previous week. Yields declined to 3%, from 3.1% on July 22. Merrill’s broad Provincial Bond Index debt was up 2.4% in July, and 4.7% this year.

Canada’s gross domestic product shrank 0.3% in May, the most in two years, to $1.26 trillion on a seasonally adjusted basis, as production in the mining and oil and gas sector declined, government data showed. Economists in a Bloomberg News survey forecast output expanding by 0.1%, based on the median of 24 responses.

Canada’s dollar sank after the data, dropping as much as 1% and ending the week 0.8% lower at 95.52 cents per U.S. dollar in Toronto in the worst weekly performance among all its 16 most-traded peers except Mexico’s peso. The loonie touched 94.07 cents July 26, the strongest since November 2007.

Bank of Canada

Bank of Canada policy makers on July 19 kept the benchmark policy rate at 1% and said borrowing costs will rise, omitting the word “eventually,” which had appeared in previous statements.

Moody’s Investors Service affirmed Canada’s Aaa credit rating on July 28, citing the country’s economic resilience and low susceptibility to risk, as well as the government’s financial strength.

Rogers’s 6.11% bonds maturing in August 2040, with $800 million outstanding, were among the best performers in July on Merrill’s broad Canada index, returning 6%, data through July 28 show. The Toronto-based company is the nation’s biggest wireless carrier with a rating of Baa2, or two notches above speculative grade.

Epcor’s 5.75% debt due in November 2039, with $200 million outstanding, was another top performer, also returning 6% in July, the data show.

Edmonton, Alberta’s municipal power producer is rated BBB+ by Standard & Poor’s, three levels higher than so-called junk debt. Quebec returned 5.7% last month with its 10% bond maturing in December 2012. The province, Canada’s second- most populous after Ontario, is rated Aa2 by Moody’s.